A Simple Guide on the Fundamentals of Real Estate Investing
April 15, 2022
Real estate investing can be a great way to hedge against inflation and diversify your portfolio today. Understanding the fundamentals of real estate investing before starting is important, though. Today there are many ways to invest in real estate, even if you only have a few dollars to start.
Real estate is no longer reserved for wealthy investors. Here's everything you must know to get started.
What Is Real Estate Investing
Real estate investing is what you make it. Traditional real estate investors buy residential property and use it as a rental property. They collect monthly rent and enjoy the property's equity buildup and eventual capital appreciation (capital gains).
But there are many other ways to invest in real estate too. You don't even have to physically own an investment property to invest in real estate. There are opportunities for crowdfunding, fractional investments, and even buying shares of a real estate company that invests in real estate.
The sky's the limit, but all real estate investments have a few things in common. They all can benefit from cash flow, appreciation, and diversifying your portfolio.
Why Invest in Real Estate
Many people wonder why they should invest in real estate. For some, it's a strategy reserved for the wealthy, but today investing in real estate is accessible to anyone, including non-accredited investors.
There are many reasons to consider becoming a real estate investor, but here are the most common reasons.
- Real estate appreciates - Like any investment, there's no guarantee your property will appreciate, but historically, real estate increases in value, especially when it's held for the long term.
- You can build equity - If you buy and hold real estate or invest in a real estate investment trust, the real estate will likely appreciate, meaning you build equity in it. As a result, you may increase your wealth by investing in buy and hold real estate either directly or through an investment company.
- You may earn capital gains - The ideal investment strategy is to buy low and sell high, just like any investment. However, if you invest in an appreciation investment property either directly or through crowdfunding/REITs, you may earn capital gains when you or the owner sells the property for a gain.
- Real estate diversifies your portfolio - It's never a good idea to keep all your money in one investment. If you're looking for long term gains, add real estate to your portfolio and hold onto it for a few years at a minimum. You might offset the risk of a loss in the stock market or any other investments you choose.
How Can You Invest in Real Estate
Like we said earlier, real estate investors have many options to invest in real estate today. Successful real estate investors diversify their funds throughout many different properties and even investment types so that an investment gain can potentially offset an investment loss.
Here are the top choices you have when making an investment decision involving the real estate market.
Buying a rental property is the most common investment strategy for real estate investors. You buy a property, hold it and rent it out to tenants. You can manage the property yourself as the landlord or outsource the task to a property management company. Either you or your property management company is responsible for the upkeep and property maintenance, screening tenants, collecting rent, and paying the property taxes.
If you'd rather not hold onto homes and deal with tenants, you can buy and flip properties. This strategy works best in a real estate market with undervalued properties with room for improvement and higher values.
You'll need a good relationship with reputable contractors that can do quality work and do it on time so you can stay on track with selling (flipping) the property for a profit within six months to a year.
REITs are investments in a real estate company or a company that buys and manages investment properties. This is a way to invest in real estate without directly owning the properties. Many REITs are available with very low investment minimums required (sometimes as low as $100), yet you can invest in real estate and build wealth.
REITs often pay dividends from monthly rental income or monthly interest if you invest in a property's debt rather than equity. Investors also earn equity buildup and capital appreciation when the investment matures.
Real estate investment groups are like REITs, but instead of buying company shares, you purchase units of the property from the company that owns the building. You can buy one unit or several. You aren't responsible for the unit's maintenance, repairs, or even finding tenants. The REIG handles those tasks, but in exchange, charges a fee that comes off the profits you earn from owning an investment property.
Real Estate Limited Partnerships
Real estate limited partnerships are partnerships of investors (like yourself) and a property manager who is the general partner and oversees the entire investment property. The investors aren't responsible for the care and maintenance of the property or the day-to-day activities, but they receive disbursements from monthly rental income plus the profits when the general partner sells the property for a profit.
If you'd rather have a real hands-off approach to real estate investing, mutual funds in a real estate company are a great way to become a real estate investor. You automatically get a diversified real estate portfolio without putting forth too much capital.
Real estate crowdfunding occurs on investment platforms that bring together builders/real estate developers and investors like yourself. The platform crowdfunds the money needed to build or expand a property, making each person that invests in the property a real estate investor.
What to Know Before Investing
Before you invest in real estate, you should understand a few important terms to make the right decision when finding the best way to build wealth with real estate.
Commercial vs Residential Properties
You generally have two options when looking at properties - commercial or residential.
Commercial property is any property used for business. You could invest in retail centers, shopping malls, freestanding stores, office buildings, warehouses, and factories in the traditional sense. Commercial real estate also includes things like apartment buildings or hotels, and even hospitals and medical buildings. Most commercial real estate investments require a lot of money and are reserved for experienced investors with a lot to invest.
Residential properties are properties you buy to rent out to families or individuals. They include single-family homes, condos, townhomes, and PUDs. Any property you buy to either hold and rent to tenants or to fix and sell to individual buyers is residential property.
Accredited vs Unaccredited Investors
We mentioned earlier about being an accredited investor. Here's what it means.
If you're an accredited investor, you have an annual income of at least $200,000 for the last two years and/or a net worth of at least $1 million. This is why some institutional-quality real estate investments are reserved for accredited investors because they have the funds needed for larger investments.
Non-accredited investors have many opportunities to invest in real estate, too, though. Non-accredited investors don't need to prove a minimum income amount or net worth. While non-accredited investors can always buy individual properties, there are many REITs and other real estate investment options for non-accredited investors too.
Real estate historically hedges against inflation. In other words, real estate values typically increase with inflation. This is often the opposite of what happens in the stock market. When costs increase for companies, their profits typically decrease, which means stockholders lose money.
When real estate appreciates, investors earn more because they can sell the property for more than they bought it, realizing capital gains.
Real Estate Investing Pros
- Real estate often appreciates, which can lead to capital gains
- You can diversify your portfolio
- You may earn monthly cash flow
- You can invest in the equity or debt side of real estate
- Anyone can invest in real estate
- The real estate market typically bounces back even after a crash
Real Estate Investing Cons
It's important to understand the downsides of a real estate business or even individual investments in real estate, such as REITs, to know what you stand to lose.
- There's no guarantee real estate will appreciate in the timeline you have for your investment
- Monthly cash flow isn't guaranteed for investment properties since renters can default or even leave the property vacant
- Not every property investment is a good deal
- Owning real estate can be very labor-intensive
- There's a lack of control when you invest in a REIT, REIG, or mutual fund
How Risky Is Investing in Real Estate?
Most, if not all, investments have some risk. So is it risky choosing real estate? It can be, but it can also be a lucrative way to make money. You can limit your risk by doing your own due diligence on the real estate investments you or a real estate group make to know your risk and your reward.
What Is the Safest Real Estate Investment?
No real estate investment is the 'safest.' It depends on the market you're in, what the real estate market cycle is like in your area and how you invest. It's always a good idea to diversify your investments to minimize your risk of a total loss.
Understanding the fundamentals of real estate investing is the key to making money in real estate. Of course, there will always be risks in any investment, but if you do your research, understand what you're investing in, and have a sound investment strategy, you can make investing in real estate work for you. Learn more by signing up and visiting our blog.
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